The Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), which was signed into law in June of 2001, made several changes to the federal tax law which were scheduled to take effect gradually. With the new year approaching, we would like to remind our clients and friends of tax law changes that will take effect on January 1, 2004.
1. Increase in Estate Tax Exemption. EGTRRA provided for gradual increases in the amount that an individual can pass tax-free at death (referred to as the "exemption equivalent"). Effective January 1, 2004, the estate tax exemption equivalent will increase to $1,500,000 (up from $1,000,000 in 2003). It will increase to $2,000,000 in 2006 and $3,500,000 in 2009, with the estate tax being repealed in 2010 for that year only and reinstated in 2011 at a $1,000,000 exemption. Note that the gift tax exemption will not increase in 2004 or later years, but will remain at $1,000,000. As a result of the increase in the estate tax exemption equivalent taking effect in January, clients with wills that provide for the establishment of a bypass trust on the death of the first spouse or any other bequest of the estate tax exemption equivalent should review the titling of their assets, the value of their estate and how the increase affects their overall plan. For example, consider the following:
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If maximum funding of a bypass trust at the death of the first spouse makes sense despite the potential New Jersey estate tax effect it may have (discussed separately in this newsletter), then you will want to be sure that each spouse has sufficient assets in his or her name to use the higher exemption amount to the extent possible.
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Beneficiaries who are to receive the exemption equivalent will now receive up to $500,000 more than they would have received when the exemption equivalent was $1,000,000, and beneficiaries who are to receive the balance of an estate after disposition of the exemption equivalent will receive up to $500,000 less (and may receive nothing if the $1,500,000 exemption equivalent is greater than the value of the estate).
2. Increase in Generation-Skipping Transfer ("GST") Tax Exemption. The GST tax is generally imposed where property is passed to grandchildren or more remote descendants. Effective January 1, 2004, the exemption from GST tax will increase to $1,500,000 (up from $1,120,000 in 2003). The GST exemption will increase to $2,000,000 in 2006 and $3,500,000 in 2009, the GST tax will be repealed in 2010 for that year only and reinstated in 2011 at an exemption of $1,000,000 plus inflationary adjustments. As a result of the upcoming increase, clients should note the following:
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The increase in the GST tax exemption from $1,120,000 to $1,500,000 provides an opportunity for wealthier clients to make an additional $380,000 of GST-exempt transfers, even if they have already used up their entire $1,120,000 exemption that was available prior to January 1, 2004.
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Clients who have created or will create those types of trusts that are prohibited from having GST exemption allocated to them until the end of a certain term (such as grantor retained annuity trusts - "GRATs") will now have more GST exemption available to allocate to those trusts when the term ends (assuming the term ends prior to the year 2011 and allocation of GST is desirable because the trust assets will pass to grandchildren or more remote descendants). This is helpful since the assets in the trust may have appreciated by the time the term ends.
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Clients with wills that contain formula bequests that refer to the maximum available GST exemption will now pass up to an additional $380,000 under that bequest, assuming this exemption is not used during lifetime. Consequently, other beneficiaries would receive up to $380,000 less. Clients should therefore review the value of their estate and ensure this result comports with their intentions.
3. Decrease in Maximum Estate and Gift Tax Rate. Effective January 1, 2004, the maximum estate and gift tax rate will be 48% (down from 49% in 2003).
4. Increase in Reduction of State Death Tax Credit. A credit is allowed against the federal estate tax for death taxes paid to any state. The credit is based on the adjusted taxable estate. EGTRRA provided for the gradual reduction of this credit. Effective January 1, 2004, the credit will be reduced by 75% (from only a 50% reduction in 2003). This means that for the estates of decedents who die in 2004, there will be a lower state death tax credit available to offset the federal estate tax.
5. Increase in Contribution Limits for 401(k), 403(b), 457, SEP and SIMPLE Plans. Effective January 1, 2004, the maximum amount that can be contributed to a 401(k), 403(b), 457 and salary reduction simplified employee pension plan ("SEP") will be $13,000 (up from $12,000 in 2003). The maximum amount that can be contributed to a savings incentive match plan for employees ("SIMPLE") will be $9,000 (up from $8,000 in 2003). In addition, if you are age 50 or older and your plan allows catch-up contributions, you will be able to save even more. The maximum catch-up contribution permitted for 401(k), 403(b), 457 and SEP plans will be $3,000 in 2004 (up from $2,000 in 2003). The maximum catch-up contribution for SIMPLE plans will be $1,500 (up from $1,000 in 2003). Note that the maximum contribution for IRAs will not increase in 2004, but will remain at $3,000 for individuals under age 50 and $3,500 for individuals age 50 or older.
6. Increase in Deduction for Qualified Higher Education Expenses. Under EGTRRA, an above-the-line deduction was added to the tax law for qualified higher education expenses paid by taxpayers. In 2003, taxpayers with adjusted gross income that does not exceed $65,000 ($130,000 in the case of married couples filing joint returns) are entitled to a maximum deduction of $3,000. Effective January 1, 2004, taxpayers with adjusted gross income that does not exceed $65,000 ($130,000 in the case of married taxpayers filing joint returns) are entitled to a maximum deduction of $4,000, and taxpayers with adjusted gross income between $65,000 and $80,000 ($130,000 and $160,000 in the case of married taxpayers filing joint returns) are entitled to a maximum deduction of $2,000. Taxpayers with adjusted gross income above these thresholds cannot claim any deduction.
Year-End Reminder: Remember to make any remaining gifts for 2003 by December 31 (see the guidelines discussed separately in this newsletter). Gifts made in 2003 which aggregate more than $11,000 for any donee must be reported on an IRS Form 709 United States Gift (and Generation Skipping Transfer) Tax Return by April 15, 2004.
